The “science” of economics today is not merely and institutionalized form of neo-feudal philosophy, nor is it merely an ideology of darkness that erects institutions to promote more darkness. It has become a form of madness, a dream of human imagination we mistake for a pattern of the world. It is a path not merely to serfdom but to death.

We do have an alternative, though. We can believe what we see with our own eyes.

(Barry C. Lynn, Cornered: The New Monopoly Capitalism and the Economics of Destruction, John Wiley & Sons, 2010, p.252)

In recent months I have occasionally reflected on why, as a grad student at the University of Michigan, I decided to leave the PhD program in economics and to enroll in the law school. Mostly, I think, I was shying away from an academic career. But I had concerns about economics as well. Milton Friedman had just published Capitalism and Freedom the year before I entered college, and debates about the role of government in the economy were heating up in the late 1960s. My professors at Oberlin had taken the Keynesian side, arguing that “supply-side” theory was unsupported and based on ideological opposition to government participation in economic affairs. I didn’t like wondering how a field like economics could be so political and still function objectively as a social “science.”

What I mostly recall today, however, are the troubling questions I had about the “microeconomic” supply and demand principles underlying most of the economics I was taught. I remember feeling something like an Atlantic sockeye salmon, swimming upstream: The theories told me what “equilibrium” would look like, if I assumed “perfect knowledge” and “perfect competition” and a host of other assumptions, none of which were ever realized in the real world. But I didn’t want to know what might happen in a hypothetical world; I wanted to know what actually happens in the real world.

A few years out of law school, as fate would have it, I was appointed to the position of Administrative Law Judge at New York’s Public Service Commission, a position I held for nearly thirty years. That job required me to decide cases involving a lot of – you guessed it – economic issues. Instead of becoming a professional economist, ironically, I had become a practicing economics professional. My job required finding answers to sometimes difficult factual and policy issues, both legal and economic, from the bottom up. It was my job not to prejudge or speculate, but to try to find the truth, and I took that responsibility seriously, refusing to respond to political pressure. For a number of years, most of the big cases involving economic and antitrust issues, like the AT&T divestiture and the Bell Atlantic-NYNEX merger, came my way. It was not clear to me that the Bell Atlantic-NYNEX merger was entirely in the public interest as proposed. It was approved in New York and Washington, however, and the result was Verizon.

None of us can claim to be right about everything. All of us may, from time to time, take comfort from some “pixie-dust” ideas, notions that are created through the application of top-down psychological preferences instead of through verifiable, bottom-up factual analyses. This is mostly harmless when the ideas are reasonably inconsequential, and we do not firmly believe them to be true, like the wonderfully entertaining superstitions in “Silver Linings Playbook” about what it takes for the Philadelphia Eagles to win football games.

There is danger, however, when we form unfounded beliefs about important things. Ironically, it is those ideas we hold by faith, without real-world factual support, that we are least willing to challenge or change in the face of contradictory evidence. Alas, the “science” of economics is riddled with such ideas.

I have long believed that market economies are unstable, and have long suspected that unfettered market economies will eventually disintegrate, succumbing to the influence of growing stagnation. One recent morning I awoke, with a strong feeling of conviction, thinking this:

Unrestrained capitalist economies are virtual inequality machines, relentlessly creating and compounding dysfunctional distributions of wealth and incomes; and the rest is pretty much inconsequential window dressing.

It dawned on me, as I thought about it, exactly how I had arrived at that conclusion. This “revelation” comes to me as I organize my materials and thoughts for a PowerPoint presentation on inequality, and consider theories on the mechanisms of economic decay. I would have no basis, of course, to offer such a remarkable claim as a scientific one, without reference to the reports and studies on detailed income and wealth distribution data which have become available over the past two or three years. Otherwise, how could I claim any more credibility for this idea than has been claimed for the economics Barry Lynn condemns as “neo-feudal philosophy”?

I told my sister about my epiphany. “Do you think this is a new idea?” she asked, a bit impatiently. “Read Barbara Tuchman’s A Distant Mirror.”

Okay, but what about modern economic theory? You may react as my wife did when I told her about my revelation: “Have you been watching MSNBC?” she asked. “That’s what everybody’s been saying.” Well, no, not exactly: Certainly there has been much discussion recently, thanks to inputs from experts like Joseph Stiglitz and Robert Reich, about how dangerous inequality is and is how it is hurting our economy, but that’s about it.

This is not an issue upon which the economics profession has taken the lead. Eighteen months ago Americans in great numbers took to the streets to Occupy Wall Street and communities all over America, seeming implicitly to understand that the dividing line in the growing income inequality gap is almost exactly the line between the top 1% and the bottom 99%. It was only six months ago, however, in July of 2012, that Stiglitz published The Price of Inequality: How Today’s Divided Society Endangers Our Future, and the likely implications of his observations are only now starting to emerge in media and professional discussions. And just a few months earlier, in May of 2012, another distinguished American Keynesian, Paul Krugman, published End This Depression Now (May, 2012), in which he tentatively argued that income inequality may be essentially a “political” problem, presumably lacking material macroeconomic consequences.

Stiglitz’s book, to the best of my knowledge, is the first significant economic text since Henry George’s Progress and Poverty (1879) to describe what I now feel is capitalism’s basic flaw. No, not even Keynes did that. Almost no one, so far as I know, has looked at instability in modern economies quite that way – not even Joseph Stiglitz, even now.

I am inspired by the reasoning of Georgist economists Mason Gaffney and, recently, Mary Manning Cleveland, an environmental and inequality economist who is a supporter of the work of Barry C. Lynn (here). This short list must also include Clifford Cobb and James Galbraith, who in a recent speech (here) skewered the notion of “normality,” and the associated belief that after each crisis “the economy will recover,” adding: “It was never made quite clear why.”

As someone whose interest and expertise comes not from academia, but from real-world experience, it is exciting to get a glimpse, in James Galbraith, of someone I might have been very much like had I gone down the academic road in life. Referring to the gap between Keynesians and supply-siders, Galbraith colorfully alludes to a “saltwater-freshwater pseudo-divide, maintaining an illusion of discourse, of conversation, yet always centered on the perfect competitive, perfect information, rational actor type,” which he calls “a form of scientific regress” and “a useless abstraction.”

What I have learned over the last two years, to my dismay, is that far too many Americans subscribe to beliefs about economics that are flat-out wrong, some of them absurdly so. Most people, including those with no economics background at all, would upon reflection likely reject ideas that are so ridiculous as to violate fundamental common sense. But when perceived truth is inconsistent with their underlying interests, those in control of the media have been able to convince people of false ideas that are not so obviously wrong.

Here is my effort to summarize the major difficulties in one blog post. This is essentially a view from a mile up, specifically designed to avoid the details over which so much debate and distraction leads to trouble. Let’s try to see, in broad strokes, where economics has gone wrong.

The flawed “classical” paradigm of “equilibrium”:

The “neo-feudal philosophy” Barry Lynn speaks of so colorfully seems to me to be a regressive outgrowth of “classical” economic theory. Galbraith reports in his wonderful lecture that ideas we think of as “classical” have been repackaged and recycled so much in different contexts that one loses sight of the original ideas. So let’s go back to the beginning.

Influenced by Adam Smith (1723-1790), the French philosopher Jean-Baptist Say (1767-1832) popularized what has become known as “Say’s law,” the idea that “supply creates its own demand.” Every sale is also a purchase, but that tautology in itself provides no useful information. The more useful idea was, and is, that aggregate supply creates aggregate demand. Here, however, is where the trouble begins: The idea that, through markets and the use of a viable medium of exchange, aggregate demand will clear aggregate supply is not a tautology. Here is a basic supply and demand curve:

All it does is describe the idea that at higher prices lower quantities are demanded and greater quantities are provided. The slopes and locations of these curves vary among circumstances. The point of intersection of these curves is known as a point of “equilibrium.” Inherent in any supply-demand analysis is the need to meet certain assumptions, like perfect knowledge and perfect competition, to actually “find” the hypothetical equilibrium point for a given product or a given market. But supply-demand analysis offers, at best, a fleeting description of a market, as these curves change location and shape over time.

The basic problem is that “equilibrium” has never been more than just a hypothetical point, especially for an entire economy. In what I conclude was Keynes’s main contribution to economic theory, his General Theory of Employment, he showed that the achievement of a market-clearing aggregate supply and aggregate demand of goods and services for an entire economy cannot even theoretically be achieved by a continuous, linear, aggregation of individual supply-and-demand equilibria, pursuant to Say’s Law.

Keynes developed a simple model with three independent variables: (1) the interest rate; (2) the propensity to consume; and (3) the marginal efficiency of capital (cost of capital). He observed that output is divided between goods and services for current consumption, and investment in the means to provide for future consumption. On the demand side, total income consists of total current consumption and total saving. On the supply side, production consists of total current consumption and total investment.

These two amounts are equivalent (Say’s Law), but as Keynes explained this equivalence led to the erroneous “classical” assumption that savings always equals investment. No law of economics, said Keynes, requires monetary savings to be immediately applied to the provision of physical investment. Savings can be hoarded. So, if the aggregate propensity to consume declines for some reason (say, increased regressivity of the taxation system), and demand falls, investors would likely perceive from the decline in demand reasons to expect lower demand in the future. Thus, Keynes famously reasoned, a decline in demand, instead of leading to more investment, would lead to higher unemployment!

In this observation, Keynes recognized the tendency of market economies to decay. No reason has since been advanced to expect demand to grow again on its own, when an economy is left to its own devices. Not ever — not unless demand is revived extrinsically and abnormally, say, by warfare. Household consumption requirements, which are spiraling down in response to declining investment and jobs, simply won’t recover on their own. In a depression, moreover, the interest rate can fall all the way to zero without providing for a schedule of the marginal efficiency of capital sufficient to promote investment and growth. And if demand is falling because of rising income inequality, as Mary Cleveland has suggested, the resulting “liquidity trap” becomes something even more debilitating, something we might call an “inequality trap” (here).

The presumption of normality:

The late James Tobin wrote in 1997 (“An Overview of the General Theory,” (here), Cowles Foundation Paper 947 ( here)) that the central economic questions of our generation are whether a market capitalist economy, left to itself, will fully employ its labor and other productive resources without government intervention, and whether it will return to full employment reasonably swiftly once displaced from it. “The answer of the General Theory,” he said, “is ‘no,'” adding: “I argue that Keynes still has the better of the big debate.”

James Galbraith, as noted, discusses how mainstream economics is enthralled by the presumption of normality, which postulates that an economy will always recover from a slump; it may take a little longer, but economies will eventually bootstrap themselves back to “equilibrium.” As Galbraith points out, no one has ever specified how that is supposed to happen. It is a matter of faith, maintained with a liberal application of pixie dust.

Inequality in the spectrum of economic thought.

Here is a brief listing of four categories of economic thought I have identified, ranging in my assessment from the craziest to the most accurate. I assign each a “pixie dust rating” (PDR) on a scale from zero to ten:

1. Supply-side ideology: (PDR = 10)

This is a collection of ideas that range from the preposterous to the simply wrong. These are ideological notions that dominate the tea party, the Republican Party, our national and many state governments. No amount of pixie dust could make any of these ideas work:

– Tax reductions for the rich pay for themselves. (Even if lowering taxes on top incomes stimulated investment and growth, it couldn’t possibly stimulate enough growth to provide for the revenues lost. And if it could, why would more tax reduction still be needed with taxes on top incomes and corporations already at their lowest point in about three generations?);

– Tax reductions for the rich stimulate growth. (No, they don’t. From 1979 to 2007, these tax cuts made enough additional revenue available to the rich to accumulate about $14-15 trillion in net worth while the federal government ran up more than $12 trillion in debt. Top 1% net worth increased nearly $12 trillion above the per capita allocation of wealth growth. Meanwhile, the overall rate of GDP growth dropped by one-third, and income inequality skyrocketed.);

– Income inequality is the difference between what someone can make with a college education and what they can make without it. (This is according to the CATO Institute, Ben Bernanke, and even the 2012 Economic Report of the President. What can I say? “We can believe what we see with our own eyes.”)

2. Monetarism: I’ll use this broad term for want of a better one for this category. (PDR = 7)

– Milton Friedman, Frederick Hayek, and others argued that Keynesian fiscal policy would be self-defeating because, to the extent it would increase the money supply, it would led to inflation. (I don’t think there’s anything wrong with this logic, assuming there is a steady level of demand. However, over thirty years of federal borrowing from 1979-2007, during which some $14 trillion of national debt was incurred, there there was no runaway inflation, no inflationary spiral; instead we got steadily declining demand, ending in a depression.);

– The interest rate can be lowered enough to induce jobs and investment in a downturn. (Evidently not in a depression. – One virtue of this line of reasoning, though, is that it acknowledges the Keynesian point that the level of aggregate demand is important, flatly contradicting the supply-side ideology that asserts growth stems from rich people saving, not from everyone else earning and spending.);

– After a downturn, the economy will always return to full employment on its own, with no need for government help. (Really?);

– Inequality is not a problem; there’s plenty of opportunity, if people are willing to work. (No – unemployment rose to extreme levels (10%) after the Crash, is still at about 8%, and is expected to stay there for several years, under mainstream assumptions. Many working people in the lower middle class, often with college degrees, are living at or near the poverty level. The decline in demand from inequality growth, in effect, ruled out any chance of runaway inflation.)

3. Mainstream Keynesianism: (PDR = 4)

– Government is a part of the economy, so its level of activity and spending affects the level of jobs and growth. (Yes) ;

– Austerity, that is reducing government spending, reduces demand, jobs, and growth. (Yes);

– Government deficit spending stimulates growth (It can, in some circumstances, but not if the countervailing force of inequality growth is depressing growth to a greater degree);

– There is no inequality or poverty problem at full employment. (Wrong – Keynes believed this, but the data show that reduced growth is accompanied by higher levels of income and wealth inequality; In a depression, high levels of inequality probably prevent a return to full employment.);

– The U.S. can stimulate the economy now through deficit spending, and pay off its huge debt once the economy is rolling again at full employment. (No – There has been constant deficit spending for more than 30 years, running up $16 trillion of debt by 2013; all of that “stimulus” merely landed the U.S. in a depression, and added commensurate levels of wealth transfers. The degree of continuous growth of inequality is now greater than any stimulus that might be gained by even well-placed federal spending and investment.);

– Inequality is a symptom of unemployment. (No. Inequality is the underlying problem, and regulating the distribution of wealth and income is government’s most important function.)

4, Georgist-Keynesianism: (PDR= 0)

– Income and wealth distribution, not employment, is the fundamental driver of prosperity and decay;

– As Stiglitz argues, inequality growth has already gone way to far in America. The U.S. is the worst among industrial countries, and suffers the worst consequences. 93% of all new income goes to the top 1%, which holds nearly half of all financial wealth. An estimated $300-500 billion of wealth (my estimate) is transferred up to the top 1% annually;

– Incomes of the top 0.01% tripled from 1979-2007, and the top 1% average income doubled, while the per capita real income of all categories in the bottom 80% declined;

– The middle class is drifting into poverty as poverty levels rise drastically; Almost all small business income left in the U.S. economy is now going to the top 1%, and wealth concentration has apparently nearly reached its practical limit;

– The majority of income and wealth going to the top 1% is economic rent, that is, income received for no productive output. Much of that, Galbraith asserts, is taken through financial transactions that are basically fraudulent;

– The economy is structured today in ways that keeps money flowing to the top (Lynn), and substantial economic regulation and re-regulation is essential to stop that process (Stiglitz, Galbraith). The economy is also threatened with potential collapse from the institutional failure of monopolistic structures (Lynn);

– Taxation must be revised to produce government revenues (as a percent of GDP) equivalent to those taking place in the 1970s. Land and resource rents, and income from non-productive activities, must be taxed more heavily and work and consumption less heavily. Government spending must be redirected into the kinds of investments for America’s future proposed by the President in the recent State of the Union Address;

There are billionaires like Warren Buffet and Howard Schultz, and the “Patriotic Millionaires,” who argue for progressive taxation and for federal budgets that preserve the middle class and promote growth, based on their understanding that their business success depends on the success of the entire economy. Such views, however, are poorly represented in Congress. America is doomed to Great Depression II unless and until Republicans, and others not fully committed to preventing such an outcome, are excluded from the halls of Congress.

One Response to Pixie Dust

I just re-read this and I’m still looking for a reasoned rebuttal, any reasoned rebuttal. To what seems like an increasing segment of the nation, “taxation” has become a trigger epithet, like “gay marriage” and “atheist”. All I find are highly emotionalized shrieks against it.